Jul 092015

In response to the Chinese stock market correction, the People’s Daily newspaper has been quoted as saying that “Confidence is more precious than gold. That’s what Chinese investors need at this moment; confidence, not panic.” No point quipping that they also need gold, as we know the Chinese have been accumulating plenty of the stuff. However it is valid to ask what impact China’s current woes may have on gold demand going forward.

[As an aside, the confidence quote seems to be on trotted out frequently, notably in 2008 about the global financial crisis when Chinese Premier Wen Jiabao said “At this moment, confidence is even more precious than gold or any currencies”, or here in 2014 regarding Zimbabwe.]

Louis James of Casey Research thinks it is negative, penning the dramatic headline “Why Millions of People Might Have to Sell Their Gold and Silver”. He says that Chinese equity investors “are suffering a major liquidity crunch. Many won’t have the cash to buy anything, not even gold” and that “huge numbers of investors are facing margin calls. That means that many who own gold will be selling because it’s the one thing they can get a bid on.”

CNN agrees with the “sell gold to pay back loans” narrative adding that stockpiles of metals may have been pledged as collateral (which firms may sell on behalf of investors). They also note that “the Chinese equities market is not just behaving badly because of mere speculative excess being worked off but indicating problems inside the economy”, which if true, could mean less gold demand going forward.

This does not sound good for gold, but UBS was reported as saying that “equities only account for 20 per cent of Chinese household wealth [and] this proportion drops further to about 12 per cent if property is included.” The Economist agrees noting that such a low share of wealth meant that “soaring shares did little to boost consumption and crashing prices will do little to hurt it” which should mean that retail Chinese gold demand should not be affected in any major way.

Nomura, quoted by FT Alphaville, also agrees that the “mechanism that channels the paper wealth of the equity market into real household consumption demand is limited in China”. Regarding the potential for margin calls and sales of collateral, Nomura note that the “leverage of margin financing done through brokerages and trust companies is generally under 3x, and the lender’s position is generally well protected as long as the equity market remains liquid enough”, the result being that we should not see significant sales of gold, assuming much has been pledged as collateral for margin loans.

There has been talk that the Chinese stockmarket correction may redirect investor money back into gold but at this time The Perth Mint is not seeing any evidence of that. Demand out of China for kilobars is low, which our Treasury believes is because bullion banks have tonnes of kilobars in stock (they usually accumulate kilobars when demand comes off and premiums are low with the intention of selling them back when premiums are good) so they are not interested in accumulating any more at the moment. The result is that kilobars premiums are way down. Our Treasury also notes that the gold arbitrage between China and London is low at around 50 cents, also indicative of a lack of interest.

Looking a bit further out, Peter Cooper at Arabian Money argues that the Chinese gold demand could get a boost given that the typical response by central banks to stock market crashes is to “lower interest rates and ease monetary conditions in liberal fashion and worry about the inflationary consequences later”. Where will the money go he asks: “likely the same place as last time: precious metals” when “gold went on a tear from under $800 to $1,923”.

Given that a significant factor behind the Chinese stock bubble was trading by retail investors, I note this article from Want China Times on the recent International Finance Expo in Guangzhou where “a total of 43 companies in the precious metals sector showcased their products created for the online age that involve apps for mobile devices or popular instant messaging service WeChat”. Just as The Perth Mint lowered its minimum investment to $50 via its new Depository Online service, the new Chinese products also “lowered the minimum investment requirement from a few thousand yuan to as low as 8 yuan (US$1.30), making investing in precious metals more accessible to investors new to the market.”

Talking of bubbles, maybe I was prescient in using the chart below in my presentation at Bursa Malaysia’s Gold Conference in June, which shows the previous Chinese stock bubble (for those not familiar with the red line bubble overlay, see Dr. Jean-Paul Rodrigue’s classic Stages in a Bubble).


The current Chinese stock market behaviour also seems to be following the same pattern.


So the Chinese have just as much form with bubble market behaviour as the West does. With 8 yuan minimum gold investments on the horizon, maybe it is fair to ask: goodbye Chinese stock bubble, hello Chinese gold bubble?